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Thursday, November 11, 2010
"Beggar Thy Neighbor." Ever heard the phrase? If you've studied the Great Depression, you have. "Beggar Thy Neighbor" is an action on the part of countries that is said to have exacerbated the Great Depression. It is when countries devalue their currency, thereby lowering prices to sell their goods more easily on world markets and, at the same time, not buying the goods of their neighbors. It is a modern version of mercantilist policy.
To understand currencies, picture the situation near to where I live. There is a circle and catercorner to each other are a High's and a Royal Farms (convenience stores for you Canadian readers), and each sell gasoline with their prices posted prominently on billboards. If one has regular gasoline at $.02/gallon less than the other, then it has a line of cars at the pumps and gets the bulk of the business for the day. In the same way, if the dollar drops versus the Euro, say, then all goods and services in the U.S. are thereby cheaper. This occurs naturally with the ebb and flow of demand and supply in the course of global trading. The problem is when currencies are aggressively manipulated by the world's largest economies. After all, isn't this what we are aggressively hammering China about?
All of this is, of course, well known by Federal Reserve Chairman Bernanke because, after all, he is a recognized expert on the Great Depression. This begs the question, therefore, of why he is pursuing a "Beggar Thy Neighbor" policy with his Quantitative Easing II program - especially given the fragile state of the world economy. He fully understands that lowering longer-term interest rates by buying bonds will cause the dollar to drop and U.S. goods to be more easily sold on global markets etc. He gets that pressuring the Chinese to increase the value of the Yuan will result in the U.S. buying less Chinese goods. He hopefully comprehends that all of this increases the odds of a trade war and is poor timing, given the state of the global economy. Even some of the Fed governors understand this.
At the same time, we have Treasury Secretary Geithner, like a parrot over in the corner, repeating the refrain that "the U.S. supports a strong dollar."
All of this has the G-20 in a tizzy and is leading to a possible confrontation at this weekend's meetings.
My prediction (going out on a limb here) is that global pressure will get the Fed to back off or at least lessen its policy and, thereby, cause the dollar to push higher, taking interest rates with it. I believe the rise in the dollar over the past couple of days reflects this expectation. Sadly, the actions of our policy makers continually make it difficult for business to operate. Who can be willing to hire workers in this environment?